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Thanks for joining us on the Monthly Market Pulse. I’m Noah Brooks, with Chris Needs, from the Investment Team at Good Life.
We have a lot to cover today, so I’m going to get right into it.
On Jobs + The Economy
We had the jobs report coming out on Friday. The economy created 336,000 jobs. It’s bringing people off the sidelines into the labor force. Hourly earnings were up 2.2%, which is a great number, and the unemployment rate was holding steady at 3.8%.
The economy is just humming along. Might be remiss, but I feel like I should say there’s a chance of a soft landing. I’d love to see it. Not a lot of negative stuff in the report, leisure and hospitality added almost a hundred thousand jobs, government added 70,000 jobs, and healthcare added over 40,000 jobs.
Chris, did you see anything negative in the report?
I think the only negative to take away from it was the initial reaction in the futures, because the rest of the day the market seemed to really love it. The market moved up all day, we ended up over a percent on some of the indices, and we didn’t have the negative drop that you would expect from a hot jobs number that we saw, particularly earlier in the week on the JOLT report, the Job Openings Labor Turnover survey report.
We saw a very hot number that day and the market did not react favorably. We saw 9.61 million job openings, versus only 8.9 expected. And for the next day or two, the market really tripped over that until we got a nice stabilization and a positive reaction from this report, which is indicating clearly a strong economy.
Yeah, strong economy, but the tale of the tape for the last quarter really was higher rates, right? And higher rates led to a bad quarter for the stock market and a bad quarter for the bond market as well. All of the major indices were down for the quarter. DOW was down, two and a quarter percent, S&P was down 3.65, NASDAQ was down over 4%, and small caps, man, they were the worst of the worst, they led the way down, Russell 2000 falling five and a half percent for the quarter.
On Small and Large Caps
Yeah, the small caps have really been struggling lately. I know at the beginning of the year we were talking about the forward price to earnings discount compared to the S&P 500, and if you’re looking at the S&P Small Cap 600, at the beginning year it was at 20%, and it has just gotten cheaper throughout the year.
At this point, it’s actually below 30% compared to the S&P 500, and I think that’s really in part due to the effective interest rates that the small caps have to pay compared to their larger cap counterparts. The larger caps, they generally have great credit ratings, super strong cash flow, and some of the small caps don’t have that luxury and weren’t able to load up on debt during the COVID crisis when rates were on zero, and it’s really starting to affect their valuations now.
Yeah, I mean, if you’re a Microsoft or an Apple and rates go up a little bit, or even a lot like they have, it’s not going to affect your earnings near as much as your small companies and your mid-caps.
Looking Back at Q3
Going back to the quarter a little bit, it didn’t start off all that bad. July was actually positive, up 3% for the month on the S&P 500, and it would actually hit a year-to-date high July 31st, which was nice to see. But the next day, Fitch, a ratings agency, came out and actually downgraded U.S. debt.
Now, that happened back in 2011 and it was much worse then, so it’s already happened, but it wasn’t great to see. Fitch doing that took some of the wind out of the market, poked a bubble in the market, if you will.
August, we lost some of that momentum from July. We were down in August, and then in September it got even worse. The market was down over four and a half percent in September, and that’s where you get the whole market being down for the quarter, with the S&P down three and a half percent.
The market just seemed to realize that the Fed is not messing around and interest rates are going to be higher for longer. I know we’ve talked about that in the past, but I think the realization that they’re going to be higher for longer, and the fact that they’re not going to be lowering in the short term, is really coming into focus.
For the quarter, what’s happened, we had a Fed meeting in July, they raised—again—25 basis points. There was no August meeting, but there was a symposium in Jackson Hole, and Chairman Powell came out and he said they are prepared to continue to raise rates if the data warrants it, and the market didn’t really like that. I think they are prepared to raise rates again, and overall the market understands that, I think.
There was no change in September. They met in September, there was no change there. There’s no meeting in October; next meeting is November, meeting after that, December. I’m going to go out on a limb, I’m going to speculate that I don’t think they’re going to raise in November.
I think they’ll be hawkish again, but I don’t think they’re going to raise in November. And there’s a reasonable chance that they’re going to raise another 25 basis points in December. As they’ve told us, they’re data dependent, so again, nothing in November would be my idea of what’s going to happen, but there’s likely a raise in December.
On Interest Rates and the Yield Curve
Yeah, so staying on that topic, since clearly they influence interest rates, J-PAL has been telling us for the longest time, higher for longer in the markets. Been trying to call his bluff, and it looks like he’s finally winning out here based on the results from the third quarter there. The long end started to move up, finally, which we haven’t seen in a really long time.
After that JOLT report, when yield spiked, we saw rates and yields, I should say, at levels not seen since before the great financial crisis. We saw the 10-year yield actually went over 4.8%, and the 30-year yield, intraday, went over 5%. So that’s a pretty nasty spike there, obviously, which was hitting markets during that Tuesday, Wednesday there.
But, what we are starting to see is the yield curve is starting to normalize. What I mean by that is, we had a very inverted yield curve for the last year plus, and the short end of rates were much higher than the long end of rates. That’s very uncommon. Normally, we have an upward sloping yield curve where the short end rates are much lower, and you get rewarded with a higher yield longer you go.
Where we’re at now is the long end has moved up significantly. It’s starting to normalize, so that’s affecting things. The high yields are affecting things across the board, business investment decisions, but it’s really also affecting the housing market.
We’re at a period right now where housing affordability is very low. Right now, two stats for you here. A median income household in the United States, buying a median priced home on the market, would be paying 44% of their income, that’s including the monthly payment, insurance-
It’s a lot.
… and taxes. But yes, exactly, Noah, that is a large chunk of your income, and historically, that is a very, very high rate. Eventually, I think that could lead to the consumer getting a little tired and not having money for extra things in the economy to go out and spend.
And again, there’s two parts to that. You have the inventory, which is low, and the yields that are high. Right now, the yields are making mortgages unaffordable, but inventory is also an issue. Why is that an issue? Because 62% of U.S. mortgage holders have a rate below 4%, and 92% have a rate below 6% percent. So again-
On the Real Estate Outlook
Well, I mean, there you go. If you were sitting at a 3.5%, 30-year, the likelihood of you moving into something else is pretty slim, especially with where they are now, right? So what was the stat that you told me earlier today? The average 30-year mortgage is at 7.5% today. So if you’re sitting on a three or 4% mortgage, I mean, there’s always exceptions to the rule, but if you’re on a three or 4% mortgage, the likelihood of you going into a 7.5% mortgage, slim to none.
Yeah, generally you’re not going to voluntarily bump up your monthly payment by 50 to 66%, unless you’re forced to. But, it’s not just here in the United States. We’ve heard about the commercial real estate issues here and abroad. It’s really a global thing.
Going internationally over to China, the second-largest economy, they’re having major issues right now with their real estate prices and property developers. Right now, their bubble is deflating and they have spiraling prices. They can’t get rid of homes. Last year, Evergrande, one of their biggest property developers, went bankrupt.
This year, just in the past week, Country Garden actually has also missed debt payments and is likely to go bankrupt. Things have gotten so bad over there that instead of paying their suppliers with cash, like normal, they were actually giving the roofers, the plumbers, all their supply people, they would give them apartments in lieu of cash because they didn’t have-
Just giving them a condo, giving them an apartment, instead of paying them? That’s not great. That’s not great.
On International Developments
Listen, sticking with the international theme, I want to bring up, it’s been about 10 years since the Greek bailout. Now, it wasn’t all in one month, but it took a while. But back in 2013, Greece essentially went bankrupt and they had to be bailed out by the European Union. The government took a lot of austerity, the European Union took a lot of austerity measures, but the government raised the retirement age for Greek workers. There were protests on the streets.
But 10 years on, they’re actually doing reasonably well, from what I read, and everybody was worried that Greece was going to leave the European Union. Well, it turns out that Greece didn’t leave, but Britain did, right? We didn’t have a Grexit, we had a Brexit. That’s a little historical fact there, going on 10 years.
In terms of what we’re watching here coming up, really one of the biggest things coming up here is the government, or the possibility of a government shutdown. We had a situation a week and a half ago where they came out with a short-term spending bill, and it seemed to work, but it’s only 45 days, so that brings us to the middle of November.
We have a situation where we could have another government shutdown, and that was one of the reasons, I mentioned earlier, with Fitch lowering the government ratings. They stated that clear as day, that was one of the reasons why they were doing a downgrade on our debt. That’s something we’re watching, in addition to the rest of the markets.
I want to thank everybody for joining us today. I’m Noah Brooks, along with me, Chris Needs, from the Good Life Investment Team. We have our eyes on the market so you don’t have to, and we hope to see you next month.
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